The Effect of ESG on the Financial Performance of Islamic Banks The Mediating Role of Sharia Compliance (2020–2024)

Abstract

This study aims to analyze the effect of Environmental, Social, and Governance (ESG) factors on the financial performance of Islamic banks in Indonesia, with Sharia Compliance proxied by the Islamic Income Ratio (IsIR) serving as an intervening variable. The study employs a quantitative approach using an associative causal research design. The sample consists of 12 Islamic Commercial Banks registered with the Financial Services Authority (OJK) during the 2020–2024 period. Data were analyzed using panel data regression, the Baron and Kenny mediation approach, and the Sobel test. The results indicate that, partially, the Environmental, Social, and Governance variables do not have a significant effect on the Islamic Income Ratio. Furthermore, each ESG dimension, as well as the Islamic Income Ratio, does not significantly affect Return on Assets (ROA) and Return on Equity (ROE). Simultaneously, ESG variables and the Islamic Income Ratio do not have a significant effect on ROA but have a significant effect on ROE. The Sobel test results reveal that the Islamic Income Ratio is unable to mediate the effects of Environmental, Social, and Governance factors on either ROA or ROE. These findings suggest that Sharia Compliance, as measured by the Islamic Income Ratio, has not yet functioned as an intervening variable in the relationship between ESG and the financial performance of Islamic banks. Nevertheless, ESG practices and Sharia compliance, when considered jointly, contribute to improving shareholders' return on equity